How Abbott Hit the Mark on China

Diplomats will always quiver when an Opposition Leader makes a bold comment about foreign and trade policy—especially when it is about our largest trading partner, which is of course China. Tony Abbott will have hit a few raw nerves in Canberra and Beijing, questioning whether China is really a “market economy” and that democratic Japan would be a much better partner to pursue a trade deal with.

The pros and cons of free-trade-agreements is a separate matter and whether we should sign one with China or Japan depends on the details. But as provocative as they might be, Abbott’s general points about China are actually on the mark in important respects.

China will continue to buy our commodities regardless of whether we sign any broader economic agreement with it or not. As 2009-2010 shows when the Australia-China diplomatic relationship reached an all-time low and exports to China kept growing, the Chinese want Australian resources not because they like us (or our policies) but because they need them and have few alternative sources.

But China’s insatiable appetite for our iron ore doesn’t mean it is a free-market economy. In fact, its system is more accurately described as a state-led and dominated one. The Australian business community might not care for this distinction but those looking to sell more than commodities to the Chinese market should for the following reasons.

The Chinese political-economy is deliberately designed in such a way that the country’s state-owned-enterprises (SOEs) are in the dominant position to benefit from the country’s economic growth—at the expense of private domestic firms and foreign companies. This was policy gradually cobbled together in the mid-1990s to retake control of the economy following the countrywide protests that almost brought down the party in 1989.

SOEs in China are given four major advantages.

First, about a dozen of the most lucrative and important sectors of the economy are effectively reserved for SOEs to compete among themselves. These include construction, infrastructure, finance and banking, insurance, resources, media and telecommunications. This means that foreign firms will not have access to the best bits of the Chinese economy.

Second, doing almost any business in China requires a permit of some kind and all permits are effectively issued by Chinese Communist Party (CCP) officials. Local governments want to protect their own locally managed SOEs. This means that any foreign company needs to curry favour with local officials in order to thrive.

Third, SOEs are given cheap loans from state-owned banks that will severely disadvantage foreign firms. If you combined with the fact that China has a largely closed capital account, have poor access to local finance, and must deal in an unconvertible currency, it is next to impossible for many foreign firms to competitively operate in China without setting up a joint venture with a local Chinese SOE.

And if an Australian firm does that, then the issues of poor intellectual property rights and a murky judicial and administrative system that is overseen by CCP officials could tragically come into play.

Finally, the Chinese consumer market—not much larger than the size of France’s—is actually a lot smaller than people think even if you were granted access to it. A large chunk of the consumer market is public (not private) consumption and Chinese firms are officially prioritised when it comes to government procurement.

So yes, Japan might be the two-decade-old sick man of Asia, but being a market economy under democratic governance has its advantages.